Can Caterpillar Continue to Grow Without China?
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The recent financial reports of Caterpillar Inc. (NYSE: CAT) for Q2 2012 were released: The company presented a very positive picture with a profit per share of $2.54 – the highest quarterly profit in its history. But this positive news was no thanks to the company's operations in China: during the first half of 2012 the company's sales declined in most of its segments in China. If not for the rise in Caterpillar's activity in Australia the company's Asian/Pacific region might not have shown any growth. Despite this very positive quarterly results, the economic slowdown in China is threatening Caterpillar's growth in the near future. In other words, without China, one of the fastest growing economies worldwide, the company's growth might eventually reach a halt. Let's examine the company's dependency in the Asian/Pacific region.
Even thought the Chinese economy isn’t expanding at a high pace as it did a few years ago, it is still rising at a high growth rate compared to the EU and the U.S. During the first quarter of the year the Chinese economy expanded by 8.1% (annual) while in Q1 2011 the economy grew by 9.6%; during Q2 2012 the GDP grew by 7.6%, while in the in Q2 2011 it rose by 9.5%.
This slowdown was also reflected in Caterpillar's performance: according to the recent second quarter reports the company states there was a drop in sales in China. On the other hand, in terms of total sales, the growth in other Asian/Pacific countries, mainly Australia, offset the decline in China's sales. The main activity that did suffer was the construction industry that declined in the Asian/Pacific region mainly because of China's decrease in activity.
On the other hand, the high oil prices (compared to the parallel time a year ago) may have contributed to the rise in power systems, mainly engines and turbines for petroleum applications. As I have pointed out in a recent post, there tends to be a positive correlation between oil prices and the company's activity.
The Asian/Pacific region and in particular the Chinese market is very important for the growth of the company: this region had a significant role in the expansion of the company's activities during last year. The company has a significant role in the growth in Chinese cement production that accounts for nearly 50% of global cement production. According to the annual reports for 2011, by 2025 there are nearly 966,000 km of new roads to pave and dozens of transit systems and airports to be built in China. Thus, in the long term there are blue horizons for Caterpillar as long as its dominance in China will continue.
In terms of sales, in the resource industry the Asian market account for nearly 30% of the company’s sales and is in a runner-up for the lead with $4.6 billion compared with $4.9 billion in sales in North America.
In the construction industry Asia is very close to becoming the leader in sales with annual revenue of $5.87 compared with an annual revenue of $5.98 in North America.
The company has plans to expand its operations in China: Caterpillar will build six new factories and facilities during 2012 and 2013 (financial reports of 2011, pg 6). This puts China as the runner up after the U.S. in regards to the number of facilities to be added in the near future.
On the other hand in the power system industry, Asia’s share in sales is much lower than in the resource industry: Asia’s sales account for 18% of total sales in this segment. In this sector North America still dominates. In financial products Asia is also a relative small contributors to sales compared to other regions.
The decline in economic activity in China during 2012 was probably due to the economic slowdown in EU and the U.S. but also due to the monetary steps the Chinese Central bank had implemented in an attempt to reduce inflation pressures: during 2011, the BOC raised interest rates and constrains on commercial banks for giving out loans in an attempt to slowdown the rising inflation so that it could reach the target of 4% (annual). Since then, the BOC changed direction: it eased the bank constrains on loans and reduced the interest rate from nearly 6.5% at the beginning of the year to 6% in July. There are also speculations that the BOC will issue a monetary easing plan in order to jump-start the Chinese economy.
The economic slowdown in China has also taken its toll on other heavy machinery companies such as Deere & Company (NYSE: DE) and Joy Global, Inc. (NYSE: JOY); the former is providing products and services primarily for agriculture and forestry and the latter in services mining equipment. But much like Caterpillar, these companies have also performed well: Deere & Company's income in Q2 2012 reached $2.61 per share (Diluted); Joy's second quarter income was $1.52 per share (Diluted); Deere & Company offers a dividend yield of 2.4%; Joy's dividend yield is 1.3%; Caterpillar's dividend yield is 2.4%;
The Foolish Bottom Line
Despite the very positive reports of Caterpillar, its growth might be in jeopardy without China's recovery. The recent changes that were implemented by the BOC might reflect in the future financial results of the company. If China will start to show some growth and reverse the recent economic slowdown, then Caterpillar will probably benefit from it so that the company could present even better financial results in the quarters to follow.
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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
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